Question

Using the information below answer the following questions.

      If    AD is……. Y = 3 (Ao - P/5)

and  

AS  is ….. Y = 20 P

     Ao = Co – mpcTo + Io + Go + Xo – Mo = 850

                 mpc = 0.8

Part 1: The Equilibrium price level  (Pe1)

Part 2: The Equilibrium National Income (Ye1)

Suppose  Government Spending increases by 35

Part 3: What is the new equilibrium price level (Pe2)

Part 4:  What is the new equilibrium national income (Ye2)

Starting again at initial equilibrium, suppose now lump sum taxes are increased
             by 28

Part 6:  What is the new equilibrium national income (Ye3)

Answer 1

AD : Y = 3( A_O - P/5)  

AS : Y = 20P

1) AD = AS (equilibrium)  

   3( A_O - P/5) = 20P

   A_O = 850  

3(850 - P/5) = 20P

2550 - 3P/5 = 20P

2550 - 0.6P = 20P

2550 = 20P + 0.6P

2550  = 20.6P

P = 2550/20.6

P = 123.78

2) Y = 20P

= 20123.78

= 2475.6

3) Now G increases by 35 which means A_o will also increase by 35

new level of A_o = 850 + 35

= 885

AD = AS

3( A_o - P/5) = 20P  

3(885 - P/5) = 20P

2655 - 3P/5 = 20P

2655 - 0.6P = 20P  

2655 = 20P + 0.6P

2655 = 20.6P

P = 2655/20.6

= 128.88

4) Y = 20P

= 20128.88

= 2577.6

5) Now lump sum taxes are increased by 28

  A_o will fall by mpc (T_o ) = 0.8(28) = 22.4

New level of  A_o = 835 - 22.4 = 812.6

AD = AS

3( A_o - P/5) = 20P

3(812.6 - P/5) = 20P

2437.8 - 3P/5 = 20P

2437.8 - 0.6P = 20P  

2437.8 = 20.6P

P = 118.33

6) Y = 20P

= 20118.33

= 2366.6